Federal Reserve Policy To Control Inflation

Federal Reserve Policy To Control Inflation 2022/5/21 下午4:24
US & WORLD ECONOMIES

US ECONOMY
How the Federal

Reserve Controls
Inflation
The Way the Fed Uses Its Tools •••
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To Manage Prices
BY K I M B E R LY A M A D E O
Updated May 04, 2022
REVIEWED BY E R I K A R A S U R E
FACT CHECKED BY D A V I D R U B I N
The primary job of the Federal

Reserve is to control in8ation while
avoiding a recession. It does this
with monetary policy. To control
in8ation, the Fed must
use contractionary monetary
policy to slow economic growth. The
Fed's ideal in8ation rate is around 2%
—if it's higher than that, demand will
drive up prices for goods. [1]
The Fed can slow this growth by

tightening the money supply. That's
the total amount of credit allowed
into the market. The Fed's actions
https://www.thebalance.com/what-is-being-done-to-control-inflation-3306095 ⾴⾯1/11
reduce the liquidity in the ]nancial

system, making it become more
expensive to get loans. It slows
economic growth and demand,
which puts downward pressure on
prices. [2]
Key Takeaways
• The Fed’s annual target

in8ation rate is 2% over
time.
• Monetary tools contract or

expand the money supply.
• These tools include the

federal funds rate, open
market operations, and
the discount rate.
• Managing people’s
in8ation expectations is
another important tool.
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Tools the Federal Reserve

Uses To Control Inflation
The Fed has several tools it
traditionally uses to tame in8ation. It
usually uses open market operations
(OMO), the federal funds rate, and
the discount rate in tandem. It rarely
changes the reserve requirement.
Open Market Operations W

TA(OMO)
BLE OF CONTENTS
The Fed's ]rst line of defense is OMO.

The Fed buys or sells securities,
typically Treasury notes, from
its member banks. It buys securities
when it wants them to have more
money to lend. It sells
these securities, which the banks are
forced to buy. That reduces the Fed's all in one
capital, giving them less to lend. As a
result, they can charge SOHO 20
higher interest rates. That slows
CLUB
economic growth and mops up
in8ation. [3]
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Fed Funds Rate (FFR)
The fed funds rate (FFR) is the most
well-known of the Fed's tools. It's
also part of its OMO. The FFR is the
interest rate banks charge for
overnight loans they make to each
other. It has the same edect as
changing the Reserve requirement
and is easier for the Fed to modify. [4]
Discount Rate
The Fed also changes the discount
rate. That's the interest rate the Fed
charges to allow banks to borrow
funds from the Fed's discount
window. [5]
Reserve Requirement
The reserve requirement was the

amount banks were required to keep
in reserve at the end of each day.
Increasing this reserve kept money
out of circulation. Changing the fed
funds rate has the same impact as
adjusting the reserve requirement.
The Fed eliminated the reserve
requirement, edective March 26,
2020. [6]
Managing Public
Expectations
Former Chairman Ben
Bernanke noted that public
expectations of in8ation are an
important in8uencer of the in8ation
rate. [7] Once people
anticipate future price increases,
they create a self-ful]lling prophecy.
They plan for future price increases
by buying more now, thus driving up
in8ation even more.
On Nov. 3, 2021, the FOMC

announced that it would allow a
target in8ation rate of more than 2%
if that would help ensure maximum
employment. It still seeks a 2%
in8ation over time but is willing to
allow higher rates to balance out
historical lower rates so that the
average is still above 2%. [8]
The Fed's history of responding to

in8ation gives you an insight into
what may work and what doesn't.
Bernanke said the mistake the Fed
made in controlling in8ation in the
1970s was its go-stop monetary
policy. It raised rates to combat
in8ation, then lowered them to avoid
recession. That volatility convinced
businesses to keep their prices high.
[9]
The U.S. Inflation Rate: 1990–

Present
8%
−2
1990 1995 2000 2005
Year-over-year change in Consumer Price Index, All

Items in U.S. City Average
Source: Bureau of Labor Statistics
History of the Fed's

Response to Inflation
Fed Chairman Paul Volcker raised
rates to end the instability. He kept
them there despite the 1981

recession. That ]nally controlled
in8ation because people knew prices
had stopped rising. [10]
Tip: The past fed funds

fate tells you how the Fed
managed the expectations
of in8ation.
The next chairman, Alan Greenspan,

followed Volcker's example. During
the 2001 recession, the Fed
lowered interest rates to end the
recession. By mid-2004, it slowly but
deliberately raised rates to avoid
in8ation. [11] [12]
How Well the Fed Is

Controlling Inflation Now
After the 2008 ]nancial crisis,
the Fed focused on preventing
another recession. During the crisis,
the Fed created many innovative
programs. It quickly pumped tens of
billions of dollars of liquidity to keep
banks solvent. [13]
Many were worried that this

would create in8ation once the
global economy recovered. But
the Fed created an exit plan to wind
down the innovative programs, and
ended quantitative easing and its

purchases of Treasurys. [14] [15]
During the 2020 pandemic, the Fed

had to ramp up its quantitative
easing and reduce interest rates to
combat the swift onset of a
recession. The federal funds rate
dropped to 0%-0.25% and helped
buoy the economy. By 2021, the
economy showed strong signs of
recovery. However, in October,
in8ation rose to a startling 6.2%
year-on-year, a level not seen since
1990. [16] [17]
By March 2022, in8ation had soared

to 8.5%, prompting the Fed to raise
interest rates for the ]rst time since
2018. [11] The Fed increased interest
rates again at the May 2022 FOMC
meeting, this time by half a
percentage point (50 basis points).
The target fed funds rate was
increased to between 0.75% and
1.00% on May 4, 2022. [18]
Frequently Asked
Questions (FAQs)
How does raising interest

rates curb inflation?
Raising interest rates increases the
costs of borrowing, and that reduces
in8ation by slowing the economy.

When rates go up, fewer people take
out loans for things like buying a
home or starting a business. In
theory, as demand slows for homes,
employees, and other goods and
services, prices will fall. [4]
Who controls inflation in

India, Japan, and other
countries?
Many countries have central banks
like the Federal Reserve. These
banks use monetary policy
operations to maintain price stability.
For example, the Reserve Bank of
India is that country's central bank.
[19] There's also the Bank of Japan.
[20] The European Central Bank
manages monetary policy across the
European Union. [21]
ARTICLE SOURCES
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Federal Reserve Policy To Control Inflation 2022/5/21 下午4:24

US & WORLD ECONOMIES

How the Federal

The primary job of the Federal

The Fed can slow this growth by

reduce the liquidity in the ]nancial

• The Fed’s annual target

• Monetary tools contract or

• These tools include the

Tools the Federal Reserve

Open Market Operations W

The Fed's ]rst line of defense is OMO.

The reserve requirement was the

On Nov. 3, 2021, the FOMC

The Fed's history of responding to

The U.S. Inﬂation Rate: 1990–

Year-over-year change in Consumer Price Index, All

History of the Fed's

them there despite the 1981

Tip: The past fed funds

The next chairman, Alan Greenspan,

How Well the Fed Is

Many were worried that this

ended quantitative easing and its

During the 2020 pandemic, the Fed

By March 2022, in8ation had soared

How does raising interest

in8ation by slowing the economy.

Who controls inﬂation in

SHARE THIS ARTICLE

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